Residential Warranty Scheme

Transcription

1 Residential Warranty Scheme

2 I. Objectives of Residential Warranty Schemes A. Why are Residential Warranty Schemes needed? The inherent nature of the construction industry nationally and in the Territory predisposes it to a disproportionately high level of contractor failure. The repetitiveness with which construction contractors fail financially and are thereby unable to complete their works or address major post-construction defects frequently results in significantly adverse consequences for residential home owners. There are a range of policy initiatives that governments across Australia have adopted to try to mitigate the consequences of contractor failure for home owners. Different models of (generally mandatory) residential warranty schemes are one such initiative. In general terms, a residential warranty scheme is a scheme implemented to provide consumers a means to be compensated by a third party fund or insurer for construction failures that a home owner cannot recover under its contract with the residential builder. It has been asserted 16 that governments, when looking at whether a warranty scheme ought to be introduced, should address: the size of the potential losses that consumers may face as a result of contractor and construction failure; the ability of consumers to be able to make informed decisions about the residential builder they choose; and the availability of a market-based solution which the consumer can access (such as private insurance) to protect themselves against contractor and construction failures. 17 What can be said about the residential building market in general terms is that: the wealth of Australians and Territorians is particularly concentrated in property. 18 For the large majority of the population their residential property is their major asset; the majority of individuals embarking on building a dwelling are entering into a building contract for the first time and it will likely be (along with buying the property) the largest commercial transaction that they enter into; home owners building their house have invariably borrowed money to fund the build and do not have financial capacity to deal with those build costs substantially exceeding their budget, including the costs of substantial delays in the project preventing occupation of the home; and post-construction defects may be identified a substantial time after completion of building (deemed to be when the occupancy permit is issued for the construction under the Building Act) and invariably when the loan for the construction has been converted into a long term home loan secured by mortgage. The costs of trying to address a major post-construction defect for a home owner can be crippling and beyond the home owner s capacity to fund if they do not have sufficient equity built up in their (new) homes to leverage further borrowings. Unit owners also suffer this problem through the body corporate having to make special calls on those home owners to fund the costs of addressing major construction defects in the common property. 16 Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p Australian Bureau of Statistics, Cat No: Building Activity Australia, April

3 Given the importance of the domestic building industry to the economic and social sustainability of the Territory, there is consensus that Government intervention is justified to protect or compensate a home owner against damage that they would otherwise suffer through no fault of their own. It is the vulnerability of the home owner that drives the consumer protection ethos of Government policy initiatives in domestic building regulation generally. It is the underpinning rationale of residential warranty schemes compensating home owners that have suffered because of contractor and construction failures. This leads to further policy and regulation questions including the question of where the balance lies between on the one hand, allowing participants in the construction market to operate unencumbered and on the other hand, the cost of distortions to the market that intervention to protect vulnerable participants in the market inevitably creates. Residential warranty schemes in Australian jurisdictions have not, generally, attempted to intervene in the residential construction sector to actively prevent or modify the particular characteristics of the industry that tend to cause contractor and construction failures in the first place. Residential warranty schemes are about dealing with the consequences of contractor and construction failures after the event. They are sometimes described as last resort measures accordingly. To immediately qualify that statement, the present MBA Fidelity Fund does attempt to take preventative steps by way of its pre-qualification criteria of residential builders. Particularly, residential builders are required to submit financial information, have financial checks and be subject to conditions which involve setting annual limits to the volume of residential jobs they can do to be able to participate in the Fidelity Fund (which is presently the only way that a contractor can satisfy the compulsory requirement for warranty cover in the Territory). Unique vulnerability of home owners Consumers who choose to build their own home are said to be particularly vulnerable since most only build once (or infrequently), as opposed to residential contractors who have years of industry experience. This infrequency of building experience on the part of consumers also means that consumers lack the technical experience concerning housing construction techniques. 19 Furthermore, many information anomalies exist between residential builders and consumers which attribute to the special vulnerability of consumers who choose to build their own home, particularly in relation to contractor failure. For example, consumers are not privy and do not have access to reliable information regarding: the likelihood that a residential builder will become insolvent or disappear during the life of the project; the quality of workmanship of the residential builder; and the health (financial or otherwise) of the residential builder. Additional reasons why it is difficult for consumers to make informed choices when building their own home have been identified to include: the potential individuality of new homes which can add complexity to a comparison of cost and quality of engaging a residential builder; the long duration to build a home which increases the risk of adverse financial and economic events arising affecting the building industry or the individual residential builder engaged; and the long life of the product which may make it difficult to assess the quality of workmanship or detect defects in the house, once built Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p

4 Why all schemes are limited in application to residential sector The prevailing position is that commercial contracting is different from domestic construction because: commercial principals are less vulnerable and can better protect themselves from contractor and construction failure than home owners; construction failure that is not caused directly by contractor failure can be better managed by commercial principals than home owners; and commercial principals generally ought to have greater financial and administrative resources to deal with contractors that are not performing contractually and this non-performance ought to be managed by commercial contactors. Often, however, commercial contractors are in no better a position than domestic home owners to assess and manage the risks of default. There are no substantial tools available for commercial principals to be able to objectively assess the risk of contractor failure or protect themselves from it. Further, it would appear that the Government also has some concerns about contractor failure for its own capital works, as it requires the accreditation of commercial and civil contractors doing work for it. The Government does not however presently require that same level of review for commercial contractors in the private sector, as the Territory s present residential builder s registration system does not extend to commercial and civil contractors. Size of potential (consumer) losses a. Deposit In the event of contractor failure, a consumer may stand to lose the value of any deposit that they paid to a residential builder prior to the commencement of the residential building work. The Building Regulations presently restrict the size of that deposit to not more than 5% of the total contract price. So, the size of the potential loss of deposit to a consumer due to a residential contractor failure can be up to 5% of the contract price. 21 Given the average price for the construction of a home in the Territory (in 2012, being the latest year for which information has been identified) was $346, a 5% loss on the price of the contract would be $17,300, which is considered a significant loss for a consumer. b. Incomplete Construction If a residential contractor failure occurs before the completion of construction, the consumer will have to engage another residential builder to complete the unfinished home. In order to be satisfied of the workmanship of the building completed so far, an incoming contractor will typically investigate the existing work and may have to demolish and rebuild any areas which that new builder or other building practitioners (i.e. a structural engineer or a certifier) do not consider to have been built to the requisite standards. In addition to those costs, the second residential builder may also charge a premium for the risks involved with finishing another contractor s building. 23 Further, the costs of mobilisation to site and establishment costs typically covered in preliminaries, will have to be paid again to an incoming contractor. It has been estimated that such costs of arranging for a second residential builder to complete a residential building can be up to 20% higher than the original contract price Building Regulations (NT), r. 41H(e). 22 Australian Bureau of Statistics, Australian Government, 2012, Building Activity: Australia, June Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p

5 Consumers that have entered into loan agreements with their banks to fund the construction of a home are often already at the outer limit of their borrowing capacity and may not be able to extend their loans or source other funds to be able to bridge such an increase in construction costs. This problem can be compounded by the costs arising from the delay in completion having to get another builder or contractors in to complete the works. Delay in the completion means that the consumer has to pay the costs of living elsewhere as well as continue to fund the construction of the new home. c. Defects Consumers also face the risk of loss arising because of defects in workmanship or materials. In the case where a contractor failure has occurred the residential builder will not be either physically or financially available to rectify defects. It is recognised that in addition to the quantum of the loss arising from construction failure, the timing of when the defect manifests itself and requires rectification, must also be considered. This is because: sometimes defects do not manifest themselves until well after the consumer has fully extended themselves financially, with the original home loan having been expended in buying the land and paying for the construction of the dwelling; many consumers do not have sufficient equity in their homes to raise further loans to fund the defect rectification costs; with serious, structural defects manifesting and remaining unaddressed for lack of funds, the consumer may not be able to sell their home either and therefore becomes trapped; and this situation is compounded where the defect becomes manifest post-construction and after the dwelling has been sold to another owner. That new home owner inherits the defects but not the original construction contract with the residential builder. Often new owners that suffer a major defect in their home have little or no legal rights of recovery against the residential builder or against the vendor and are in an invidious position. This is invariably the situation for body corporates of multi-storey residential construction. The body corporates are created after the construction is completed and occupancy permit has issued. Since all of the claims brought under the MBA Fidelity Fund were due to the last resort of insolvency of the residential builder, it can be reasonably concluded that no claims have been made under the MBA Fidelity Fund for stand-alone defects that may be covered by the limited first resort trigger of the residential builder s registration being suspended or cancelled. This Report has not identified any records of the claims for stand-alone construction failure made under the TIO administered HBCF Scheme. d. Conclusion on size and risk for consumers Since the Government resumed its administration of the HBCF Scheme in the last 2 years, the average cost of each claim made when assessed across 32 completed rectifications, was approximately $22, The average quantum of claims made under the MBA Fidelity Fund was $26,685 per claim. As stated above, the average price for the construction of a home in the Territory was $346,000 in This means that a potential loss of $22,000 to $26,000 per home (representing approximately 6% to 7.5% of the average build cost of a home) is the approximate average cost that consumers will suffer for a construction failure. This exceeds the amount of the maximum deposit allowable under the Building Regulations, which is a significant amount for a consumer to lose. As stated earlier, it is not only the quantum of the cost for the consumer, but the timing of when it is suffered, that compounds the impact of construction failure on consumers. 25 This figure is comprised of average cost of $20,500 for rectification costs, plus loss assessor average administration fee of $1,830. The costs of the Building Administration Service s staff and administration resources are not included in this figure. 46

6 B. Models of Residential Warranty Schemes Industry schemes fidelity funds Fidelity fund schemes in Australia are extended and administered by construction and housing industry associations such as the MBA or the Housing Industry Association (HIA). Residential warranty schemes have been promoted by these industry associations as examples of the industry s residential sector supporting and protecting consumers and self-regulating residential builders participating in the industry through their ability to access the compulsory scheme. The Territory and in the Australian Capital Territory are the only jurisdictions in Australia that operate a fidelity fund scheme and this is by virtue of the fact that no insurer has taken the opportunity to enter the indemnity market. Essentially the fidelity fund model of a scheme works by having residential builders pre-qualify to be able to seek cover under the scheme for their residential building projects. At this stage the administrators of the fidelity fund act as gatekeepers of which contractors can and cannot participate in the compulsory scheme and thereby who can and cannot be a residential builder. Approvals can be given with conditions including the capacity and output of each residential builder for the period of the cover. Once assessed and qualified to participate in the scheme, approved residential builders apply for and obtain fidelity certificates from the fidelity fund for each project, contributing an amount to the fidelity fund for each project. These contributions are pooled in the fidelity fund and used to provide compensation to home owners who incur losses because: their dwelling is not completed; or a defect is not rectified (e.g. construction failure), due to or coinciding with the death, disappearance, insolvency or loss of registration of their residential builder (e.g. contractor failure). In this model: the fidelity fund is the sole means by which residential builders can obtain appropriate cover required by law; contributions to the fidelity fund by residential builders is (practically) mandatory; the level of contribution is mandated at a fixed rate payable by all residential builders, irrespective of the risk of that residential builder suffering a contactor failure. The level of contribution is set to try to cover the fidelity fund s indemnity payouts and administration costs and is not intended to make a commercial return or profit for the scheme s administrator (the MBA); fidelity funds are not reinsured by the government, but are subject to statutory oversight to ensure appropriate capital is maintained by the fidelity fund; the administrative functions of the fidelity fund are administered by the relevant association; and although the cover taken out by the residential builder who has prequalified to seek and obtain certificates of cover by the fidelity fund for each project, obviously the fidelity fund extends indemnity to the residential builder s customer, the home owner. It is this consumer that receives the benefit of the last resort indemnity cover (with limitations and caps) in the event that there is both: a construction failure (the work is defective or incomplete or, in the Territory, fails the consumer guarantees now included in the Building Act); and the residential builder suffers a contractor failure (that is the residential builder becomes insolvent, disappears or dies, or its residential builder s registration has been cancelled). 47

7 Insurance schemes Private insurance schemes work on the basis that a private insurer indemnifies the beneficiary of a policy of insurance (the home owner/consumer) issued to the insured (the residential builder) for that beneficiary s damage or loss resulting from a construction failure caused or arising in the circumstances of a contractor failure. Private insurance providers necessarily determine insurance premiums based on the risk rating of the individual residential builder and seek a commercial return on the premium to compensate it for the risks assumed. The extent of the insurance cover offered in schemes can vary between full or limited cover. An example of full cover is a policy that provides cover to consumers for losses due to incomplete construction and for defects incurred within a 6 year period commencing at completion of construction. Limited cover may extend similar cover, but for shorter warranty periods, such as 2 years. In a mandatory insurance model, residential builders are required to take out insurance cover with the one or more approved insurers in the market, prior to the commencement of construction. In an opt out model, residential builders are not required to take out insurance and consumers can choose whether they engage an insured residential builder or not. Obviously it is intended there be a price differential for the consumer. This opt out model reasserts the contracting independence of the home owner to make the choice of whether they want indemnity insurance or not. Such freedom of contracting choice does however challenge the notion that home owners, as consumers, are particularly vulnerable to contractor failure (which they generally cannot control) and construction failure (which they might not have the financial and technical capacity to take on and successfully address). Whilst consumers have the freedom of choice in an opt out model, the more vulnerable consumers will likely be those that elect to opt out of cover for the benefit of the cheaper cost, which defeats the philosophy of warranty schemes generally. Inevitably, it is those residential builders offering the cheaper alternative of not carrying indemnity insurance that are more likely to be more susceptible to contractor failure. This Report consequently assumes that an opt out model does not achieve the objectives of the residential warranty scheme and will not be considered. Finally, the ability to opt out of an insurance based scheme reinforces the problem inherent with small premium pools that exists in the Territory and which threatens the viability of the private insurance model. Residential warranty schemes are often not a purely private sector model, because governments have been required to provide some form of reinsurance to encourage private insurers to participate in the scheme. For example, government may come to an agreement with an insurer with significant market share to reinsure that insurer for a specified range of loss, such as a loss resulting from the failure of a single residential builder. This may be necessary because of the significant concentration of the home building market in the hands of a few, large, contractors. Government cover Government models of residential warranty schemes are those where the government (sometimes through an agency or fund) acts as the primary provider of the indemnity cover to the consumer. In recent history, government models are generally contemplated because the other models of indemnity are simply not commercially viable in the jurisdiction. A government scheme may contemplate full or limited indemnity similar to an insurance scheme. Typically a government agency is identified as the administrator of the scheme. Occasionally, the administration of the scheme may be contracted out to another entity. If this occurs, it is important that the government scheme has strong legislative and regulatory underpinnings to ensure it is not compromised by the manner that the scheme is administered by an out-sourced administrator approaching it from a different perspective. In summary, the Government model outlined is: 48

8 a last resort indemnity model, focused on indemnifying consumers in the event of a construction failure; publically administered by a government agency or its agent, and may be fully funded, partially funded or unfunded (for the government) from any payments that may be mandated to be made by participating residential builders projects; and operationally, generally a monopoly. Cover having to be obtained by a residential builder In both the industry fidelity fund and the insurance models the consumer s entitlement to indemnity is dependent upon the issue of the certificate of coverage (the fidelity certificate under the present MBA Fidelity Fund or the insurance policy in the case of an insurance model) to the residential builder and it paying the contribution amount or premium. If the residential builder does not do the right thing and fails to obtain the relevant certificate of coverage for a home owner s particular dwelling (or a policy of insurance, under the insurance model) then no indemnity has been extended by the residential warranty scheme to the consumer. Government models of indemnity may be created and administered in a similar manner to industry and insurance models, requiring some form of certificate or evidence of indemnity cover being issued on receipt of the payment due under the scheme. However, they also have the indemnity cover for consumers prescribed in a combination of legislation, regulation and administrative instruments, so that noncompliance or fraud on the part of a residential builder (trying to evade the immediate costs of the compulsory residential warranty scheme) ought not mean the consumer loses cover under the scheme. The industry fidelity fund and insurance models are consequently more dependent upon checks and balances operating successfully to compel the residential builder to do the right thing and obtain the relevant certificate of cover or policy of insurance from the indemnity provider. Whilst relying on practical checks for the necessary cover certificates or policies by building practitioners (such as private building certifiers) gives some comfort that the necessary precondition for indemnity is being taken out by residential builders, this role needs to be formally recognised and built into the regulatory system, otherwise: the building practitioner informally charged with the job of checking for evidence of cover may be assuming a liability to the consumer that they may not have any or adequate indemnity insurance to cover themselves for; and the consumer may not have any rights at law (and may be in the challenging position of having to pursue any rights as may exist against the building practitioner and its professional indemnity insurer through the courts) to pursue recovery from that building practitioner for failing to check that the cover certificate or the insurance policy note was properly issued. Essentially, by hinging cover to consumers on compliance with the processes of issuing and paying for a policy or cover certificate, and then relying upon other building practitioners to check for this, the warranty schemes (such as the present MBA Fidelity Fund) shift compliance risk from the scheme to those other building practitioners and their professional indemnity insurance. This may significantly impact on the cost and availability of professional indemnity insurance for those building practitioners. If the residential warranty scheme intends to rely on building practitioners (and their professional indemnity insurance) to protect consumers from residential builders not properly obtaining or paying for crucial certificates of coverage in the residential warranty scheme, the impact on those building practitioners and the costs of their professional indemnity cover ought to be more thoroughly understood. 49

9 This Report identifies the range of options for the Territory to address builders avoiding compliance with the residential warranty scheme, being: relying upon that practitioner (and the professional indemnity insurance that may be standing behind them) and formalising it within the regulatory regime (recognising the impact that has on the building practitioners in question); having the residential warranty scheme provide first resort cover to consumers irrespective of whether or not the requisite cover certificate or policy note is properly obtained by the residential builder under the regulations (and to maintain a statutory release from claim 26 for other building practitioners that are required to become involved in cross-checking compliance with the scheme requirements); or that a last resort nominal insurer type arrangement be contemplated by Government to stand behind an insurance or industry (fidelity fund) model. There are circumstances where the beneficiary (the home owner) of the scheme may well not have any legal rights of recovery from the building practitioner who fails to properly check whether a residential builder has paid the appropriate fee and received the fidelity certificate or policy of insurance in place to cover their home. The home owner may not have any contractual link to that building practitioner (who may have been engaged by the residential builder directly) and the building practitioner possibly may not owe a duty of care to consumers that would allow for a claim in negligence. Also, the failure to have a valid certificate of cover for the home build may be due to fraud on the part of the residential builder, and it is not negligent for the building practitioner to have been deceived by such a fraud. Finally, the consumer may need to pursue his or her legal entitlements against the building practitioner (and its professional indemnity insurer), which can be just as hard and as expensive as pursuing a claim against a defaulting contractor, so this mechanism of relying on the building certifier to check for appropriate cover does not really address the vulnerability of the home owner that is the underpinning philosophy of the warranty scheme. There is a longstanding model in the Territory s workers compensation statutory scheme to have back up in the event there is a failure to actually obtain the compulsory employer s insurance policy. The Territory workers compensation scheme has a nominal insurer that is contributed to by a small levy from premiums and who can step in to provide compensation where there has been a triggering event (compensable injury) and compulsory insurance has not been obtained by the defaulting employer. The Territory s residential warranty scheme should apply the principle that a person ought not to lose their entitlement to compensation because of defaults and failings of others. If the Territory accepts the principle that a backstop (e.g. some equivalent administrative entity as the nominal insurer) is needed, then cost/benefit analysis might weigh in favour of simply: embracing the government model in its entirety; and ensuring the Recommended Warranty Scheme extends coverage to consumers irrespective of any non-compliance with the procedures of the Recommended Scheme by the residential builder. (That is the builder fails to pay the required levy for the consumer s residential project or otherwise is not properly registered). Civil penalties and rights of restitution of the costs can be legislated to be recoverable by the Recommended Warranty Scheme Administrator against a defaulting residential builder (and its directors, if a company) that has not complied with the requirements of the Recommended Warranty Scheme. 26 See section 153(2)(a) of the Building Act for the present immunity from suit arising from their discharge of the certification role under that Act. 50

10 Hybrid models Hybrid models of residential warranty schemes are available (in concept) by combining the cover available through insurance, fidelity fund and government schemes. The commercial practicality of achieving a successful hybrid scheme in the present commercial environment in the Territory where insurers are completely absent from the market is, however, another matter. a. Private Ancillary In the private ancillary model, the government has the role of providing a minimum level of indemnity coverage. Consumers then have the option of purchasing further private insurance to top up the indemnity. The basic level of cover offered by the government agency or fund under an ancillary model might have restrictive caps on the amount of indemnity payable, or a restricted basis upon which the indemnity responds. For example, the category of construction failure that the indemnity extends to might be quite narrow, such as limiting defects identified within a year of completion and not extending the period of indemnity to 10 years, that may then be offered in the top up private insurance policy. b. Insurance with Industry Supplement Under this model, private insurers would offer mandatory insurance protection for consumers against noncompletion of dwellings for contractor failure. Consumers that wish to guard against the consequences of post-completion construction failure (essentially defects arising after practical completion of the dwelling by the residential builder that are not rectified by the residential builder) can then avail themselves of an option to take up an indemnity issued by an industry association fidelity fund. This model is premised on a preference of consumers for mandatory protection against non-completion of works for contractor failure, with the occurrence of defects after completion being the subject of supplementary, optional cover. This hybrid model presupposes a fidelity fund is more suited to provide cover against post-construction defects since the incidence and quantum of claims ought to be lower than claims for non-completion. 27 c. Private with Government Support Nearly all private models have an element of government support underwriting the private insurer or industry to underpin the viability of the private scheme. The following table illustrates the types of schemes currently in place in Australian jurisdictions: Jurisdiction Name of Scheme Type of Model Threshold value of project before insurance is required Applicable to Cover for structural defects (after practical completion) Cover for nonstructural defects (after practical completion) Covered to a value of (subject to conditions) NSW NSW Home Building Compensation Fund Government, (private insurers act as agents) $20,000 Residential 6 years 2 years $340,000 QLD Home Warranty insurance Government $3,300 Residential 6 years 6 months 2 years $200, Final Report Inquiry into Western Australia s Home Indemnity Insurance Arrangements (Economic Regulation Authority (June 2013), p

11 Jurisdiction SA VIC ACT WA NT TAS Name of Scheme Building Indemnity Insurance Domestic building insurance Housing indemnity insurance Home indemnity insurance MBA Fidelity Fund N/A (voluntary insurance) Type of Model Hybrid - Private with Government reinsurance Government and private Private, plus MBA Fidelity Fund Private with government reinsurance Hybrid - MBA Fidelity Fund with Government reinsurance Threshold value of project before insurance is required Applicable to Cover for structural defects (after practical completion) Cover for nonstructural defects (after practical completion) Covered to a value of (subject to conditions) $12,000 Residential 5 years 5 years $80,000 $16,000 Residential 6 years 2 years $300,000 $12,000 Residential 6 years 2 years $85,000 $13,000 Residential 6 years 6 years $100,000 $12,000 Residential 6 years 1 year $200,000 N/A N/A N/A N/A N/A N/A C. Present scheme: overview of the Territory MBA Fidelity Fund MBA Fidelity Fund in concept a. Legislative background The Government announced in July 2010 that it would move to introduce consumer protection measures following the collapse of a number of residential builders. 28 The MBA Fidelity Fund was created concurrently with a suite of legislative reform in 2012 which formed the Residential Building Cover Package. The following legislative instruments comprise the Residential Building Cover Package: Building Amendment (Registration and Other Matters) Act 2012; Building Amendment (Financial Assets and Residential Building Contracts) Regulations 2012; Building Amendment (Residential Building Consumer Protection) Act 2012; Building (RBI and Fidelity Fund Schemes) Regulations 2012; Building (Resolution of Residential Building Work Disputes) Regulations. b. Application of mandatory cover The Building Act provides that a residential builder undertaking prescribed residential building work worth more than $12,000 in the Territory must take out cover under either: an authorised RBI policy; or 28 Second Reading Speech, Building Amendment (Residential Building Consumer Protection) Bill

12 a fidelity certificate. 29 Collectively, this is referred to as Residential Building Cover. The mandatory requirement for a residential builder to take out Residential Building Cover arises when that residential builder undertakes work of at least $12,000 in value, for the construction of the following buildings: a new Class 1a building (which are houses, duplexes, townhouses) and an extension to a Class 1a building; a new Class 2 building up to three residential storeys (which are apartments, units, flats); an extension to a Class 2 building (also only if the Class 2 building does not exceed 3 residential storeys); a Class 10 building (which includes garages, retaining walls, verandahs) attached to a Class 1a or 2 building (under three residential storeys), if the Class 10 building is constructed at the same time as that building; or a Class 10 building that is a retaining wall (whenever constructed) that is not attached to a relevant building but on which the integrity of the relevant building depends. The Building Regulations require relocated houses to be brought up to building standards in force at the time of relocation, unless the house is being moved to a rural area. Buildings that are relocated to rural areas under that exemption do not require Residential Building Cover. All other relocated houses, where the value of the work is over $12,000, will require the cover. Work that does not require Residential Building Cover includes: work that has a value of less than $12,000; renovations or alterations to an existing building (Class 1a or Class 2 up to 3 residential storeys) that do not increase the floor area of the existing building (unless the renovation under the same contract with the same residential builder that is carrying out an extension), including re-cladding of roofs or walls, replacement of windows, construction of new external openings and enlargement or filling in of existing external openings; prefabricated dwellings; all other classes of buildings and Class 2 buildings that exceed 3 residential storeys; and work done for the Government. An authorised RBI policy is a policy under which an approved residential building insurer provides residential building insurance in accordance with the Building Act. 30 A fidelity certificate is a certificate which is issued by an approved fidelity fund scheme. 31 As there is no residential building insurer operating in the Territory it is only a fidelity certificate issued by the MBA Fidelity Fund that will provide protection to an owner for financial loss incurred because of a residential builder s failure to complete the work or contravention of a consumer guarantee and: 32 the residential builder has died, disappeared or gone insolvent; 33 or the residential builder s registration has ceased Building Act (NT), s. 54AB(1). 30 Building Act (NT), s. 54CB. 31 Building Act (NT), s. 54D. 32 Building Act (NT), ss. 54C(a), 54D(2)(a). 33 Building Act (NT), ss. 54C(b)(i), 54D(2)(b)(i). 34 Due to the circumstances in Part 3 Div 3B, 3C or 4 of the Building Act: Building (RBI and Fidelity Fund Schemes) Regulations (NT), r 8(3), Building Act (NT), ss. 54C(b)(ii), 54D(2)(b)(ii.) 53

13 These contractor failures are the trigger events that enable an owner to make a claim. The ability to make a claim can be represented as follows: Work is defective or incomplete No contractor failure Contractor failure Cover from MBA Fidelity Fund Does not apply MBA Fidelity Fund will provide cover, subject to caps c. Consumer Guarantees The Building Act contains a number of consumer guarantees which apply to building work of any value in connection with residential building work, including that: the residential builder carrying out residential building work (residential builder) will carry out the building work in a proper and workmanlike manner in accordance with the plans and specifications specified in the building permit for the work and the contract (if applicable); all materials supplied by the residential builder will be good and suitable for the purpose for which they are to be used and new (unless the builder is an owner builder or developer of the contract specified otherwise); the residential builder will carry out the building work in accordance with the Building Act and the Building Regulations; the residential builder will carry out the building work with reasonable care and skill; and the residential builder will complete the work by the date specified in the contract or, if no date is specified, within a reasonable period. 35 These consumer guarantees cannot be excluded from a contract for residential building work and are in addition to other consumer rights in force under any other law. 36 Essentially these consumer guarantees are codifying those terms that courts have historically (but not always consistently) implied into construction contracts that are silent on the subject. If the residential builder contravenes a consumer guarantee resulting in defective residential building work, the current home owner can claim for a breach of the consumer guarantee: up to 1 year after the end of the construction period (usually from when the occupancy permit is issued) for non-structural defects; and 35 Building Act (NT), s. 54B. 36 Building Act (NT), ss. 54BA-54BC. 54

14 up to 6 years after the construction period (usually from when the occupancy permit is issued) for structural defects. 37 If the current home owner becomes aware of the defect within 30 days of the end of the defect period, that defect period can be extended for a further 30 days. 38 Consumer guarantee dispute resolution process A current home owner can only apply to the Commissioner of Residential Building Disputes (the Commissioner) for a decision about a consumer guarantee dispute where there is no contractual relationship between the current home owner and the contractor in relation to the residential building work to which the dispute relates. 39 This includes situations where: the work has been completed under the contract and the parties consider the contractual obligations fulfilled; or regardless of the state of the work, the parties relationship has broken down irretrievably. 40 If the Commissioner makes a decision that one or multiple consumer guarantees have been breached the Commissioner may: Where the breach of the consumer guarantee involved the non-completion of work, order the respondent to complete the work or where that order would be impracticable, the respondent to pay a specified amount (not exceeding $100,000) as compensation to the applicant. 41 Where the breach relates to defective work, order rectification of that work, or where that order would be impracticable, the respondent to pay a specified amount (not exceeding $100,000) as compensation to the applicant. The Commissioner may also require the respondent to pay the costs of inspection of the rectified work. 42 If the contractor fails to comply with a rectification order, this will constitute professional misconduct 43 entitling the Building Practitioners Board (BPB) to take disciplinary action including the possible suspension or cancellation of that contractor s registration. 44 If the contractor fails to comply with a completion or compensation order, that contractor may be subject to disciplinary action, including the possible suspension or cancellation of that contractor s registration. 45 Consumer guarantee dispute resolution process where a trigger event has not occurred If a trigger event of contractor failure has not occurred, and there are allegations by the current home owner of defective or incomplete work, the home owner may apply to the Commissioner to seek to resolve the dispute arising from the breach of a consumer guarantee. Despite this consumer guarantee dispute resolution process, unless there has been some form of disciplinary action or review under the residential builders registration system having led to the revocation of the residential builder s registration under the Building Act, the home owner cannot access the RBI policy or fidelity fund for compensation for the breach of the consumer guarantee. Consumer guarantee dispute resolution will provide access to recovery under mandatory cover only when trigger event has occurred Where a trigger event for access to the present scheme has occurred and there are breaches of the consumer warranties, the home owner can apply for relief under the RBI policy or fidelity fund. These 37 Building (Resolution of Residential Building Work Disputes) Regulations (NT), r. 7(2). 37 Building (Resolution of Residential Building Work Disputes) Regulations (NT), rr. 7(2)-7(7). 38 Building (Resolution of Residential Building Work Disputes) Regulations (NT), r. 7(7). 39 Building Regulations (NT), r. 18(1). 40 Building (Resolution of Building Work Disputes) Regulations, r Building (Resolution of Building Work Disputes) Regulations, r Building (Resolution of Building Work Disputes) Regulations, r Building Act (NT), s. 34X. 44 Building Act (NT), s. 34Y, Building (Resolution of Building Work Disputes) Regulations, r Building Act (NT), s. 34Y, Building (Resolution of Building Work Disputes) Regulations, r

15 rights are expressly stated to not exclude any other rights or remedies which the home owner has under the Australian Consumer Law. 46 Consumer guarantees do not necessarily displace express terms of the construction contract or the ability to argue equivalent contractual terms are implied into the parties construction contract by operation of law. Importantly, where the construction contract is at an end, or a dispute arises under the construction contract such that the residential builder refuses to rectify the defect or non-compliance, the avenue for the consumer to pursue the breach of consumer guarantee before the Commissioner remains open. d. Scope of mandatory cover The ambit of the coverage of the fidelity certificate or authorised RBI policy is prescribed by the Building (RBI and Fidelity Fund Schemes) Regulations. These regulations prescribe that the authorised RBI policy or fidelity certificate must cover: loss for defective guaranteed work (including defective design work under a contract) or the noncompletion of guaranteed work; the costs of alternative accommodation, removal and storage for a period not exceeding 60 calendar days, reasonably incurred as a result of the defective guaranteed work or non-completion of the work; the loss of a deposit or progress payment under a contract relating to the work (except the payment of a deposit or progress payment above the amount specified in the contract relating to the guaranteed work); legal or other reasonable costs incurred in seeking to have a residential builder rectify or complete the work; an increase in costs for rectification of the work caused by the passage of time; any acts or omissions of persons engaged as contractors by the residential builder in relation to the work; and any additional reasonable costs associated with engaging another residential builder to rectify or complete the work (excluding the costs associated with the work carried out by that builder). 47 e. Limits and exclusions on mandatory cover The Building (RBI and Fidelity Fund Schemes) Regulations also prescribe what ought not to be covered by the authorised RBI policy or fidelity certificate: the payment of a deposit or progress payment above the amount specified in the contract relating to the guaranteed work; if the beneficiary is a subsequent purchaser of the residential building defects that are readily apparent at the time of purchase; damage that could reasonably be expected to result from fair wear and tear or from the current owner of the building failing to maintain the work; damage caused by a person or made worse by the failure of the current owner to take reasonable and timely action to minimise the damage; legal liability resulting from any event that is not expressly insured under the policy; a defect that is due to residential building work (including design work) or materials not specified in the contract relating to the guaranteed work (for example, materials supplied by the contracting owner); 46 Building Act (NT), ss. 54B, 54BC. 47 Building (RBI and Fidelity Fund Schemes) Regulations rr. 8, 14, 17, 45,

16 a person's injury or impairment (including injury or impairment of the person's mental condition), death, disease or illness; loss of rent, income, value or opportunity; inconvenience or distress; the unreasonable refusal of the beneficiary to allow access to the insurer, or the insurer's agent, for the purpose of assessing the beneficiary's claim; the failure of the beneficiary to maintain adequate protection against pests; the malfunction of any mechanical or electrical equipment if the insurer can prove the malfunction was not attributable to the workmanship of, or installation by, the residential builder; fraud or dishonest conduct of any kind by the residential builder; an appliance; asbestos contamination or removal; and war, civil unrest, a nuclear event or an act of nature. 48 In the event of non-completion of the work by the residential builder, the current home owner is covered for 90 days commencing from the earlier of when the residential builder stopped or failed to start work. 49 A claim must be made under the authorised RBI policy or fidelity certificate within 90 days of the beneficiary of the policy becoming aware of the defect. 50 Cover available under the authorised RBI policy or fidelity certificate must be at least 20% of the contract price, up to a maximum of $200,000. The excess that can be charged to the home owner is capped at $ f. Operation of the Fidelity Fund The Building Act provides for the operation of a fidelity fund on very similar terms to the equivalent ACT legislation. 52 The Explanatory Statement to the Building Amendment (Residential Building Consumer Protection) Bill 2011 states that Division 4 and 5 of the Building Act are in fact modelled on the ACT scheme. The Building Act and the Building (RBI and Fidelity Fund Schemes) Regulations set out in precise detail how a fidelity fund is to be established and operated: 53 The trustees of the fidelity fund must apply to the Minister for approval to issue fidelity certificates. 54 The Minister will assess the relevant fidelity fund and grant approval subject to conditions, if certain criteria are satisfied. 55 Prudential standards regarding financial and actuarial matters and recording have been prescribed for approved schemes. 56 Penalties, including cancellation or suspension may apply for non-compliance with conditions and prudential matters. 57 The Minister also has powers of inquiry regarding the ability of the approved scheme to meet its liabilities and potential liabilities Building (RBI and Fidelity Fund Schemes) Regulations (NT), r Building Act (NT), s. 54B(2); Building (RBI and Fidelity Fund Schemes) Regulations (NT), r. 7(2); Building (Resolution of Residential Building Work Disputes) Regulations (NT), r. 7(2). 50 Building (RBI and Fidelity Fund Schemes) Regulations (NT), rr. 19, Building (RBI and Fidelity Fund Schemes) Regulations (NT) rr. 18(2), 49(2). 52 Building Act 2004 (ACT). 53 Building Act (NT), ss. 54D-54FF; Building (RBI and Fidelity Fund Schemes) Regulations (NT), rr ; Building Act (NT), s. 54DA(1). 55 Building Act (NT), s. 54DA(3). 56 Building (RBI and Fidelity Fund Schemes) Regulations (NT), Part Building Act (NT), s. 54DD-54DE; Building (RBI and Fidelity Fund Schemes) Regulations (NT), r Building Act (NT), s. 54DE(1)(b); Building (RBI and Fidelity Fund Schemes) Regulations (NT), r

17 The appointment of auditors and actuaries by the approved scheme must be approved by the Minister. 59 Prudential standards apply to these positions and the individuals concerned will incur monetary penalties if they do not comply with the relevant prudential standards. 60 The actuary must, as soon as practicable after the end of every financial year, calculate the appropriate amounts that a builder is required to contribute to the scheme. 61 Assets of the approved scheme may only be used for prescribed purposes regarding the operation of the scheme and must be invested in certain ways. 62 The trustees must always have an approved capital management plan which has certain monetary minimum threshold requirements. 63 At the end of every financial year the trustees of the approved scheme must submit annual reports to the Minister regarding financial and actuarial matters, and to the Commissioner of Consumer Affairs regarding the operation of the scheme, including the number and type of claims made to the approved scheme. 64 MBA Fidelity Fund in practice a. Practical administration of the MBA Fidelity Fund Although the Building Act has been drafted to include mandatory cover under either an authorised RBI policy or a fidelity certificate, the industry-run fidelity fund is currently the only operational way to obtain the compulsory cover in the Territory. The fidelity fund is operated by the MBA as a not-for-profit trust. As there are currently no authorised insurers to issue authorised RBI certificates, all residential builders in the Territory have to register with the MBA Fidelity Fund. To obtain a fidelity certificate, the residential builder must first satisfy the MBA of its eligibility. The MBA requires residential builders to apply for an eligibility re-assessment every year in order to maintain their coverage with the MBA Fidelity Fund. An annual contribution is payable by the residential builder towards their MBA Fidelity Fund cover. It does not appear that any publically available policy or criteria is set out by the MBA which prescribes the specific requirements regarding a residential builder s eligibility for fidelity cover. It is emphasised that the requirements for residential builder s registration under the Building Act administered by the BPB (such as the requirement to hold a minimum of $50,000 in net tangible assets), is a completely separate process and there is no sharing of information between the registration system and the MBA s eligibility criteria to participate in the MBA Fidelity Fund, requiring some duplicity of red tape and costs for residential builders. The application form for builders sets out the following financial and commercial information from applicants: personal details; business structure information; building experience and building company ownership experience; financial (insolvency) history; financial position including credit referees, personal and business assets and liabilities; and an estimation of the future value of projects to be undertaken for the year. 59 Building Act (NT), s. 54E. 60 Building Act (NT), s. 54EC. 61 Building (RBI and Fidelity Fund Schemes) Regulations (NT), rr Building (RBI and Fidelity Fund Schemes) Regulations (NT), rr Building (RBI and Fidelity Fund Schemes) Regulations (NT), rr Building (RBI and Fidelity Fund Schemes) Regulations (NT), rr

18 The MBA states that it uses an independent chartered accountant to assess a residential builder s eligibility and assign the residential builder with a rating reflecting the residential builder s risk profile. 65 We understand that the MBA assesses the financial probity of residential builders by sending the information gathered on their application forms to an independent Chartered Accountant in Canberra. This is partly because it has experience in the operation of the ACT fidelity fund scheme and partly to ensure confidentially and objectivity in the assessment, being disassociated from the Territory. The assessment considers the trading structure (i.e. company, sole trader, trust etc.), character, capital, capacity and collateral of the applicant. We have been informed that the financial assessment is only one aspect of the overall assessment, however the whole of the assessment criteria employed, and their relative weighting, are not publically available. Also, it is understood that the report and recommendations of the Chartered Accountant are delivered to the MBA, but the decision to extend admission into the MBA Fidelity Fund (and the conditions of that acceptance) are ultimately determined by the MBA Assessment Panel, which includes senior members of the building industry. The rating limit imposed in the annual assessment of a residential builder applying to the MBA Fidelity Fund caps what a residential builder can take on by assigning a monetary limit on the value of projects that the residential builder can undertake in one year. 66 Residential builders can apply for a free re-assessment if they think their assigned value is too low. 67 Once it has received the MBA s approval, before commencing work, a residential builder must: pay the contribution for the fidelity certificate; give a copy of the fidelity certificate to the building certifier that has been engaged (often by the builder itself) to issue the building permit and to ultimately issue the occupancy permit; and give a copy of the fidelity certificate to the home owner. If the value of the contract varies during the course of the works by more than 5% the builder must apply for a varied fidelity certificate. The cost of the fidelity certificate is invariably passed onto the home owner in the contract price charged under the construction contract. b. Costs of the MBA Fidelity Fund to industry and consumers The cost paid to the MBA for the individual fidelity certificates confirming cover by the MBA Fidelity Fund for the job is called a contribution rate. The MBA website publishes the applicable contribution rates, which do not appear to have been revised since The contribution rate is a tiered system and is allocated depending on the value of the contract. The current contribution rates (as published) 68 are set out below: Contract Value Contribution Rate $12,000 - $24,999 $700 $25,000 - $74,999 $850 $75,000 - $94,999 $900 $95,000 - $99,999 $1, Master Builders Northern Territory, Process Sheet, available from 66 Northern Territory Government, Residential Building Cover Package: Questions and Answers. 67 Available from: (accessed August 2015). 68 Available from: (accessed August 2015). 59

19 Contract Value Contribution Rate $100,000 - $149,999 $1,300 $150,000 - $199,999 $1,550 $200,000 - $249,999 $1,750 $250,000 - $299,999 $2,000 $300,000 - $349,999 $2,200 $350,000 - $399,999 $2,450 $400,000 - $449,999 $2,650 $450,000 - $499,999 $2,900 $500,000 - $549,999 $3,100 $550,000 - $599,999 $3,350 $600,000 - $649,999 $3,550 $650,000 - $699,999 $3,800 $700,000 - $749,999 $4,000 $750,000 - $799,999 $4,250 $800,000 - $849,999 $4,450 $850,000 - $899,999 $4,700 $900,000 - $949,999 $4,900 $950,000 - $999,999 $5,150 $1,000,000 - $1,099,999 $5,350 $1,100,000 - $1,199,999 $5,600 $1,200,000 - $1,299,999 $5,800 $1,300,000 - $1,399,999 $6,050 $1,400,000 - $1,499,999 $6,250 $1,500,000 - $1,599,999 $6,500 $1,600,000 - $1,699,999 $6,700 $1,700,000 - $1,799,999 $6,950 $1,800,000 - $1,899,999 $7,150 $1,900,000 - $2,000,000 $7,400 $2,000,000 $7,400 plus $450 for each additional 60

20 Contract Value Contribution Rate $200,000 Developers (where the builder is the owner of the property but who are not one off owner builders) are entitled to a 10% discount. For multi-unit developments (where one builder is constructing adjacent units or houses) there is a discretionary scale of discounts depending on the financial assessment of the builder, the builder s experience and quality of previous work and the number of contiguous units (commenced together) according to the following scale: 69 Number of Units Maximum Discount 2 to 5 up to 5% 6 to 10 up to 10% 11 to 20 up to 15% 21 to 50 up to 20% The following table compares the costs of cover under the MBA Fidelity Fund in the Territory with the Queensland Home Warranty Insurance Scheme and the Victorian Domestic Building Insurance Scheme: Contract value Territory contribution 70 Queensland premium 71 Victoria premium 72 $12,000 $700 $218 $ $50,000 $850 $ $ $100,000 $1,300 $1, $ $300,000 $2,200 $3, $1, $500,000 $3,100 $4, $2, $1,000,000 $5,350 $5, $1, $2,000,000 $7,400 $5, $2, Key: Most expensive Least expensive 69 Available from: (accessed August 2015). 70 Available from: (accessed August 2015). 71 Based on rates published on QBCC website. Available from: (accessed August 2015). 72 Based on rates published on VMIA website for Category A structural works. Available from: (accessed August 2015). 61